High volatility descended on markets in March 2020 as a result of the coronavirus pandemic, providing market participants with an ocean of concerns -- as well as opportunities. Investors had plenty of oversold stocks to choose from and were presented with a rare opportunity to get stock in great companies at deeply discounted values. As a result, 2020 was a record year for retail activity in the stock market.
Data from the time showed that retail traders got more involved, accounting for 25% of the total market trades in August 2020 after being involved in just 17% of trades months earlier in January 2020. In addition, according to Piper Sandler, average daily volume in equities was 10.9 billion in 2020, nearly 55% higher than 2019 daily volume averages. That high volume has continued into 2021.
Financial services firms like Virtu Financial (VIRT 0.52%) that help manage that trading volume have openly embraced the elevated volatility and benefited from their efforts to facilitate the trades.
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Virtu Financial posted record results last year thanks partly to that elevated volatility. But in spite of record profits in 2020, investors haven't necessarily rewarded the company with a higher valuation. The company's current price-to-earnings (P/E) ratio of 6 suggests the market is concerned that Virtu's underlying business could decline as volatility decreases.
However, I think the firm is too deeply discounted, as its investments in technology in recent years have diversified revenue, making it a more stable company. That suggests this company is a good value play right now. Here are some other reasons why.
Virtu is a key player in global markets
Virtu Financial is a market maker that provides liquidity to global markets. As a market maker, Virtu makes it easier and more efficient for investors to open or close out their stock or options trades. Market-making firms like Virtu have helped push the trend of zero-commission trades, as they stand ready to take orders at a moment's notice and make money on the bid-ask spread as opposed to charging commissions. In times of high volatility, such as last March, the bid-ask spreads widen, and create profit opportunities for firms like Virtu.
The high volatility so present in the market last year is why Virtu posted record profits. It posted $3.2 billion in revenue on the year, up 113% from just the year before. Profits were driven largely by the company's market-making operations, which accounted for $2.6 billion (80%) of the company's total revenue. This helped the company's net income attributed to shareholders go from a $59 million loss in 2019 to a $650 million profit in 2020.
Virtu has done a stellar job of building its market-making reach. In December 2020, the firm ranked fifth in share of the U.S. trading market at 9.4%. It trailed the major exchanges of NYSE, Nasdaq, and Cboe, and another huge market maker, Citadel Securities. Virtu is the second-largest market maker in the space, and it continues to invest in technology to maintain and expand its global reach. For example, in its recent quarterly earnings, it announced it was expanding its symbol coverage related to its options market-making division.
Can 2021 keep pace with last year for Virtu?
One primary concern is that Virtu won't be able to maintain the same level of profitability in 2021. As a vaccine is widely distributed, and uncertainty related to the COVID-19 pandemic wanes, markets could go back to a low-volatility regime as we have seen for periods of time in 2017 and 2019. The problem for Virtu is that these periods have been tough on the firm's top- and bottom-lines.
Low volatility will hurt the market maker's profitability. However, the company has made moves to diversify away from relying so much on this volatile revenue stream. In recent years, Virtu invested $2 billion to acquire companies like KCG Holdings -- which gave it a place in retail wholesale market-making for stock trading platforms like Charles Schwab and Robinhood -- and Investment Technology Group -- which helps to facilitate trades for institutional investors. Both of these acquisitions were made to shore up the company's revenue streams and provide stability through its execution services segment (for which it earns commissions to execute trades on behalf of large institutional investors).
Prior to the company's acquisitions, Virtu was receiving 96% of its total trading revenues from market-making and 4% from other activities. In 2020, the company generated 80% of its total revenues from its market-making and the remaining 20% from execution services. And during a much less volatile 2019, the firm generated 32% of its total revenues from execution services. This diversification of income streams is an integral part of Virtu's success going forward.
Virtu is a great company at a good price
Despite efforts to diversify its revenue, Virtu still sports a cheap valuation with a P/E ratio of 6 and a price-to-book ratio of 4.1, both on the low end in the young firm's history, which started trading publicly in 2015.
The company executed 1.27 billion customer orders in 2020, and January equity volume remained high, with $621 billion in notional volume. However, management doesn't expect that high level of activity to continue through the year. That's where the stability of its execution services segment is key.
Its execution services segment posted a record quarterly adjusted net trading income of $135 million in the fourth quarter. Management has poured more resources into this segment and should get more credit for that. To me, Virtu is a value stock positioned well in the global marketplace. Its diversification of revenue streams helps stabilize earnings, making the company worth strong consideration as a value stock investment.
